CHAPTER 1

INTRODUCTION TO CORPORATE GOVERNANCE

WHAT IS GOVERNANCE?

Generally, governance refers to a process whereby elements in society

wield power, authority and influence and enact policies and decisions
concerning public life and social upliftment.

It comprises all the processes of governing — whether undertaken by the

government of a country, by a market or by a network — over a social
system and whether through the laws, norms, power or language of an
organized society.

Governance therefore means the process of decision-making and the

process by which decisions are implemented (or not implemented)
through the exercise of power or authority by leaders of the country
and / or organizations.

Governance can be used in several contexts such as corporate governance,

international governance, national governance and local-governance.

The focus of this book is on Corporate Governance.

CHARACTERISTICS OF GOOD GOVERNANCE

Whatever context good governance is used; the following major characteristics

should be present:
These characteristics are briefly described as follows:

Participation by both men and women is a key cornerstone

of good governance. Participation could be either direct or
through legitimate institutions or representatives. It is important to
point out that representative democracy does not necessarily mean
Participation that the concern of the most vulnerable in society would not be
taken into consideration in decision making. Participation needs
to be informed and organized. This means freedom of association
and expression on one hand and an organized civil society on the
other hand.
Good governance requires fair legal frameworks that are
Rule of Law enforced impartially. It also requires full protection of human
rights, particularly those of minorities. Impartial enforcement of
laws requires an independent judiciary and an impartial and
incorruptible police force.
Transparency means that decisions taken and their
enforcement are done in a manner that follows rules and
regulations. It means that information is freely available and
Transparency directly accessible to those who will be affected by such
decisions and their enforcement. It also means that enough
information is provided and that it .is provided in easily
understandable forms and media.
Good governance requires that institutions and processes try
Responsiveness to serve the needs all stakeholders within a reasonable
timeframe.
Good governance requires mediation of the different interests
 in society to reach a broad consensus on what is in the best
interest of the whole community and how this can be achieved. It
Consensus Oriented also requires a broad and long-term perspective on what is
needed for sustainable human development and 'how to achieve
the goals of such development. This can only result from an
understanding of the historical, cultural and social contexts of a
given society or community.

Equity & Inclusiveness Ensures that all its members feel that they have a stake in it
and do not feel excluded from the mainstream of society. This
requires all groups, but particularly the most vulnerable, have
opportunities to improve or maintain their well-being.

Effectiveness & Good governance means that processes and institutions

Efficiency produce results that meet the needs of society while making the
best use of resources at their disposal. The concept of efficiency
in the context of good governance also covers the sustainable use
of natural resources and the protection of the environment.
Accountability Accountability is a key requirement of good governance. Not
only governmental institutions but also the private sector and civil
society organizations must be accountable to the public and to
their institutional stakeholders. Who is accountable to whom
varies depending on whether decisions or actions taken are
internal or external to an organization or institution. In general,
an organization or an institution is accountable to those who will
be affected by its decisions or actions. Accountability cannot bet
enforced without transparency and the rule of law.
CORPORATE GOVERNANCE: AN OVERVIEW

Corporate governance is defined as the system of rules, practices and processes

by which business corporations are directed and controlled. It basically involves
balancing the interests of a company's many stakeholders, such as shareholders,
management, customers, suppliers, financiers, government and the community.

Corporate governance is a topic that has received growing attention in the

public in recent years as policy makers and others become more aware of the
contribution good corporate governance makes to financial market stability and
economic growth. Good corporate governance is all about controlling one's
business and so is relevant, and indeed vital; for all organizations, whatever size
or structure.

The corporate governance structure specifies the distribution or rights and

responsibilities among different participants in the corporation, such as the board,
managers, shareholders, and other stakeholders, and spells out the rules and
procedures for making decisions on corporate affairs. By doing this, it also
provides the structure through which the objectives are set and the means of
attaining those objectives and monitoring performance.
 PURPOSE OF CORPORATE GOVERNANCE

The purpose of corporate governance is to facilitate effective, entrepreneurial and

prudent management that can deliver long-term success of the company. In simple
terms, the fundamental aim of corporate governance is to enhance shareholders'
value and protect the interests of other stakeholders by improving the corporate
performance and accountability. It is also about what the board of directors of a
company does, how it sets the values of the business firm.

OBJECTIVES OF CORPORATE GOVERNANCE

The following are the basic objectives of corporate governance:

l. Fair and Equitable Treatment of Shareholders

A corporate governance structure ensures equitable and fair treatment of al!

shareholders of the company. In some organizations, a group of high net-
worth individual and institutions who have a substantial proportion of their'
portfolios invested in the company, remain active through occupation of top-
level positions that enable them to guard their interest. However, all
shareholders deserve equitable treatment and this equity is safeguarded by a
good governance structure in any organization.

2. Self-Assessment

Corporate governance enables firms to assess their behavior and actions

before they are scrutinized by regulatory agencies. Business establishments
with a strong corporate governance system are better able to limit exposure to
regulatory risks and fines. An active and independent board can successfully
point out deficiencies or loopholes in the company operations and help solve
issues internally on a timely basis.

3. Increase Shareholders' Wealth

Another corporate governance's main objective is to protect the

long-term interests of the shareholders. Firms with strong corporate
governance structure are seen to have higher valuation attached to
their shares by businessmen. This only reflects the positive
perception that good corporate governance induces potential
investors to decide to invest in a company.

4. Transparency and Full Disclosure

Good corporate governance aims at ensuring a higher degree of

transparency in an organization by encouraging full disclosure of
transactions in the company accounts.
BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE

Effective corporate governance is transparent, protects the rights of

shareholders and includes both strategic and operational risk management.
It is concerned in both the long-term earning potential as well as actual
short-term earnings and holds directors accountable for their stewardship
of the business.

The basic principles of effective corporate governance are threefold as presented

below:

Positive to the following questions indicate n firm's conformance and compliance

with the basic principles of good corporate governance:

A. Transparency and Full Disclosure

• Does the board meet the information needs of investment

communities?
 • Does it safeguard integrity in financial reporting?
• Does the board have sound disclosure policies and practices?
Does it make timely and balanced disclosure?

Can an outsider meaningfully analyze the organization's actions

and performance?

B. Accountability

• Does the board clarify its role and that of management?

Does it promote objective, ethical and responsible decision

making?
Does it lay solid foundations for management oversight?
Does the composition mix of board membership ensure an
appropriate range and mix of expertise, diversity„ knowledge and
added value?
Is the organization's senior official committed to widely accepted
standards of correct and proper behavior?

C. Corporate Control

• Has the board built long-term sustainable growth in shareholders'

value for the. corporation?

• Does it create an environment to take risk?

Does it encourage enhanced performance?
Does it recognize and manage risk?
Does it remunerate fairly and responsibly?
Does it recognize the legitimate interests of
stakeholders?
 Are conflicts of interest avoided such that the
organization's best interests prevail at all
times?

ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF

CORPORATE GOVERNANCE AND BEST PRACTICE
RECOMMENDATIONS
 Principles of Good Corporate Best Practice Recommendations
Governance
1. A company should lay solid 1-a. Formalize and disclose the
foundation for management and functions reserved to the board and
oversight. It should recognize those delegated to management.
and publish the respective roles
and responsibilities of board
and management.
2. Structure the board to add value. 2-a. A board should have independent
Have a board of an effective directors.
composition, size and 2-b. The roles of chairperson and chief
commitment to adequately executive officer should not be
discharge its responsibilities and exercised by the same individual.
duties.
2-b. The board should establish a nomination
committee.

3. Promote ethical and responsible decision 3-a. Establish a code of conduct to guide the
making. Actively promote ethical and
directors, the chief executive officer (or
responsible decision-making.
equivalent), the chief financial officer (or
equivalent) and any other key executives as
to:
 The practices necessary to maintain
confidence in the company’s integrity; and
 The responsibility and accountability of
individuals for reporting and investigating
reports of unethical practices
3-b. Disclose the policy concerning trading in
company securities by directors, officers and
employees.
4. Safeguard integrity in financial reporting. 4.a. Require the chief executive of (or
Have a structure to independently verify equivalent) and the chief financial officer
and safeguard the integrity of the (or equivalent) to state in writing to the
 company's financial reporting. board that the company's financial
reports present a true and fair view, in all
material respects, of the company's
financial condition and operational
results and are in accordance with
relevant accounting standards.

4.b. The board should establish an audit

committee.

4.c. Structure the audit committee so that it

consists of:
 Only non-executive or
independent directors;
 An independent chairperson, who
is not chairperson of the board;
and
 At least three (3) members.

5. Make timely and balanced disclosure. 5.a. Establish written policies and
Promote timely and balanced disclosure procedures designed to ensure
of all material matters concerning the compliance with IFRS.
company. 5.b. Listing Rule disclosure requirements
and to ensure accountability at a
senior management level for
compliance.

6. Respect the rights of shareholders and 5.a. Design and disclose a communications
facilitate. the effective exercise of those strategy to promote effective
rights. communication with shareholders and
encourage effective participation at
general meetings.
5.b. Request the external auditor to attend the
annual general meeting and be available
to answer shareholder questions about
the audit.
7. Recognize and manage risk. 7-a. The board or appropriate board
Establish a sound system of committee should establish policies
risk oversight and management on risk oversight and management.
and internal control. 2-a. The chief executive officer (or
equivalent) and the chief financial
officer (or equivalent) should state to
the board in writing that:

 The statement given in accordance with

best practice recommendation 4-a (the
integrity of financial statements) is
founded on a sound system of risk
management and internal compliance
and control which implements the
policies adopted by the board; and
 The company's risk management and
internal compliance and control system
is operating efficiently in all material
respects.
8. Encourage enhanced
8-a. Disclose the process for performance
performance. Fairly review and
evaluation of the board, its
actively encourage enhanced
committees and individual directors,
board and management
and key executives.
effectiveness.
9. Remunerate fairly and 9-a. Provide disclosure in relation to
responsibly. Ensure that the level the company's remuneration
and composition of remuneration policies to enable investors to
is sufficient and reasonable and understand:
that its relationship to corporate  The costs and benefits of those policies;
and individual performance is and
defined.  The link between remuneration paid to
directors and key executives and
corporate performance.

9-b. The board should establish a

remuneration committee.
9-c. Clearly distinguish the structure of
nonexecutive director's remuneration
from that of executives.
9-d. Ensure that payment of equity-
based executive remuneration is
made in accordance with thresholds
set in plans approved by
shareholders.

10. Recognize the legitimate interests of 10-a. Establish and disclose a code of
stakeholders. Recognize legal and other conduct to guide compliance with
obligations to all legitimate stakeholders. legal and other obligations to
legitimate stakeholders.
 REVIEW QUESTIONS
Questions

1. l. What does governance mean?

2. Explain whether the following statement is true or false.
"Governance is exercised only by the government of a country
3. Explain how governance can be used in the following contexts and give
appropriate examples:
i. national governance
ii. local governance
iii. corporate governance
iv. international governance

4. Explain briefly the eight (8) basic characteristics of good governance.

5. Transparency and accountability are synonymous. Explain whether the

statement is correct or not.

6. Explain whether the following statement is true or false.

a. "Responsiveness usually results to effectiveness and efficiency ".

7. Define corporate governance.

8. What does corporate governance structure involve?

9. State the purpose of corporate governance.

10.Explain the basic objectives of corporate governance.

11.Explain the three basic principles of effective corporate governance.

Multiple Choice Questions

1. The basic principle of "transparency and full disclosure" for effective

corporate governance responds positively to the following questions
except.
a. Does the board of director’s safeguard integrity in financial
reporting?
b. Does the board meet the information needs of investment
communities?
c. Can an outsider meaningfully analyze the firm's actions and
performance?
d. Has the board built long-term sustainable growth in shareholders'
value for the corporation?

2. The basic principle of "accountability" for effective governance answers the

following questions positively, except

a. Does the board recognize and manage risk?

b. Does the board lay solid foundations for management oversight?
c. Does the composition mix of board membership ensure an
appropriate range and risk of expertise diversity, knowledge added value?
d. Does the board promote objective, ethical and responsible decision
making?

3. "Transparency and full disclosure" principle advocates the following

except
a. Sound disclosure policies and practices
b. Solid foundations for management oversight
c. Meeting the information needs of investment communities
d. Safeguards integrity in financial reporting

4. The rights of shareholders can be effectively upheld through the

following measures except
a. By establishing an audit committee
 b. By designing and disclosing a communications strategy to promote
affective communication with shareholders.
c. By encouraging active participation at general meetings.
d. By requiring the external auditor to attend the annual general

meeting and to answer questions about the audit.

5. To safeguard integrity in financial reporting, the business firm should do

the following except
a. Establish an audit committee
b. Request the external auditor to attend the annual general meeting
e. Disclose the functions reserved to the board and those delegated to
management
d. Disclose the policy concerning trading in company securities by
directors, officers and employees.

6. To encourage enhanced performance by the board and management, it is

recommended that the following should be adopted except
a. Disclosure of the process for performance evaluation of the board, its
committees, individual directors and by executives.
b. A remuneration committee
c. Distinguish between non-executive director's remuneration from that
of executives.
d. Establish policies on risks oversight and management
7. The characteristic of good governance where fair legal framework are
enforced impartially is
a. Participation
b. Rule of Law
c. Equity
d. Accountability